The Fourteenth Banker Blog

October 6, 2010

Mortgage Mess Battle Lines Being Drawn

Filed under: Running Commentary — thefourteenthbanker @ 10:52 AM

Two new posts today articulate where the battle lines are beginning to take shape in the Mortgage Foreclosure Fraud mess. Because few mortgages are held on bank balance sheets, having been sold into Mortgage Trusts which support Mortgage Backed securities (MBS), there are parties who may find themselves at cross purposes. Then again, mortgage investor coalitions may try to hang together, lest they all hand separately. Regardless of the extent to which groups of investors do or do not become antagonistic, individual renegades will doubtlessly stir the pot.

So this Zero Hedge post points out, while referencing the WSJ, that three of the parties involved in the typical deal form a sort of triangle. I guess this is like a love triangle, after the lovin’? They are connected to one another but also opposed to one another. The mortgages are held in a Mortgage Trust. Cash flow from the Trust is paid out to the various classes of bondholders. There are always Senior bondholders and Junior bondholders. Much of the paper referred to as “toxic” is that held by Junior bondholders. They take the first loss. With the declines in real estate values and large numbers of defaults, the first losses are quite large and may in some cases be 100% for some Junior classes. But, while the Mortgage Trust still lives, the loan Servicer must advance moneys to make the interest payments on the bonds. So the longer the Trust is alive, the more payments the Junior bondholders get. The Senior bondholders don’t like this. In seeking their recovery, they would like the Trust to unwind as quickly as possible and the recoveries to be credited to them. They do not want to trade time for cash flow, because some of that cash flow goes to other creditor classes. Because these classes are at cross purposes, the likelihood of litigation is very high.

To wit: junior bondholders will rejoice as they will receive payments for the duration of the halt/moratorium (these would and should cease upon an act of foreclosure), while senior bondholders will suffer, as the deficiency money will come out of the total “reserve” in the pooling and servicing agreement set up by the servicers. As for the servicers themselves, they should be “reimbursed by funds in the trust for all costs related to litigation and extra processing of foreclosures, provided they follow standard industry practices.” In other words, it will now become “every man, sorry, banker for themselves” as each party attempts to preserve as much capital as possible given the new development: juniors will push for an indefinite foreclosure halt, seniors will seek an immediate resumption of the status quo, while the servicers stand to get stuck with billion dollar legal and deficiency fees if it is found that “standard industry practices” were not followed. Alas, it would appears that the servicers have by far the weakest case, and the impact to the banks, whose sloppy standards brought this whole situation on, will be in the tens if not billions of dollars. Oh, and suddenly both junior and senior classes will be embroiled in very vicious, painful, and extended litigation with the servicers. Lots of litigation.

As you can see, the litigation will doubtlessly be directed at the loan servicers who created this next generation of destruction. If it can be proven that the loan servicers did not follow the proper servicing procedures, they will be liable for damages. We are talking billions of dollars in damages.

Naked Capitalism raises additional issues around the jockeying that is taking place. The servicers are mostly large banks and Ally Financial. Three of these have suspended foreclosures while the do document reviews to determine the extent of the problem, and to buy time for lawyers and lobbyists to cast about for solutions like the Ringwraiths.

Per Naked Cap:

Yves here. This development reveals how this battle is likely to play out. Now that judges in some states are starting to take these dubious, potentially fraudulent measures seriously, the next line of attack is to get the more bought and paid for Federal government to intercede on behalf of the banks. As the e-mail by the Ohio Secretary shows, this is a state versus Federal rights issue. And the problem is that these solutions will be depicted as “efficient,” just as securitizations and other “innovations” were.

And while efficiency in theory is a good thing, it must always be kept secondary to the overall integrity of the system, otherwise, you run the risk of breakdown. Using dubious arguments to overturn well settled law to get the banking industry out of a monster mess it created is a Faustian bargain. It makes it abundantly clear what is really at stake here, which is the rule of law. Banks that were quick to defend unjustifiable pay deals by invoking “sanctity of contract” have no inhibition about ignoring their own contracts to pad their bottom line, and ultimately, the wallets of top executives.

Rather than deal with the considerable consequences of these abuses, the banks are prepared to bulldoze well settled state laws to give them an easy way out. And I’m not basing my view on this story alone; I had a conversation yesterday with a Congressional staffer who matter-of-factly said (but with little understanding of the underlying issues) that Congress would intervene on behalf of the industry, via its authority over national banks.

The “document reviews” are being done internally and any report on the findings should be taken with several grains of salt. The interest of the banks is to minimize their culpability.

A referee will be needed to sort this out. Perhaps Sheriff Elizabeth Warren will step into the gap.



  1. Another great piece 14th. Yves Smith , as usual, really gets some detail. Let me add another. A very big, but unknown number, of MBS Bonds were sold as strips. What has interested me for some time is the principle only first tranche. These POee’s get only principle payments during the distribution period and first. Principle payments would include the proceeds from a foreclosure and a payoff. The garden variety financial type would understand that this particular first Tranche Bond would sell at a great discount as the principle payments increase as the mortgage cash flow matures and is paid off. But , a smart guy that swa the debacle would load up on this particular variety of bond. Essentially, they get all the proceeds of payoff from foreclosures up front up to the limit of total principle payments they bought in the MBS Bond Agreement. But, this type of bond and tranch would price out assuming a long holding period to get their money back. With the crisis, they get paid back in full in perhaps 10-15 % of the priced timing of cash flows they bought. Here would be a killing in the neighborhood of multiples that John Paulson made if the top tranche POee exists in sufficient numbers. The faster the foreclosure, the greater the gain.

    Comment by Jerry J — October 6, 2010 @ 11:48 AM | Reply

    • Let me illustrate the foregoing. Let’s use a single mortgage of $150,000 with a cash flow of $1000 a month for thirty years. The total cash flow is $360,000. The estimated life of the loan before payoff is 15 years. The POee here collects a maximum of $150,000 over 30 years but gambles in his discount pricing that he gets $125,000 back at the end of year 15. He would pay a discounted amount for the cash flow stream of $150,000. Just for fun, I arbitrarily use $30,000. The loan goes sour at the end of year 2 and is foreclosed at say $149,000 including a make good from mortgage insurance. He got back $1000 by the end of year 2 in the monthly payments. Well this guy got $ 150,000 back in two years but paid only $30,0000. Obviously, this guy made 5 to one. A contrived example because I use only one mortgage. Think of the possibilities in a pool of 5000 mortgages where you bought first tranche principle only. Think what the price of this MBS would have been in early 2009? Think of the killing even on a first tranche MBS bond? The strips aspect is not much talked about.

      There are huge speculator potentials in pushing foreclosures to any limit the speculator can get away with. Most of these deals were made palatable by mortgage insurance requirements and even more so by the CDS. These were teasers to market the mortgage initially.

      None of these players expected a mass collapse of values from a panic. But that is always true of people that assume a panic will not happen.

      Again, note my kickers in the above example…. the CDS and mortgage insurance. Both were structural. They won without even an efficient foreclosure recovery. But, a new Satan entered the fray…. mass collapse of the person taking on the CDS risk and the end of the mortgage insurer.

      Comment by Jerry J — October 6, 2010 @ 2:42 PM | Reply

  2. Congress to the rescure with a new federal law. It of course is not to the benefit of the people.

    “The law, the “Interstate Recognition of Notarizations Act,” requires all federal and state courts to recognize notarizations made in other states.

    The law specifically includes “electronic” notarizations stamped en masse by computers.”

    Comment by ella — October 7, 2010 @ 8:05 AM | Reply

    • Obama has said he will not sign it.

      Comment by thefourteenthbanker — October 7, 2010 @ 1:26 PM | Reply

    • Nice link!

      It’s incredible how filthy the ties between Washington and Wall Steet have become!

      Notice it passed the house in April, isn’t that right about the time these employee depositions were made?

      I wonder if those big shit, sorry I meant big shot, but shit sounded pretty good too 🙂 anyhow, I wonder if they all are starting to get the feeling the game’s up!

      Comment by Vocalbanker — October 7, 2010 @ 2:15 PM | Reply

      • When I heard on the radio last night that they wanted to accept and approve even notarizations done basically by rubber stamp, I thought somebody must be kidding. I am amazed that the people who most loudly proclaim the sanctity of “property rights” see no problem with using a corrupt tool that would actually put such rights in jeopardy. I guess they really do make up their own rules as they go along.

        Comment by Sandi — October 7, 2010 @ 3:06 PM

  3. Obama says he will simply pocket veto this little bit of legal pimpery. All can really, really see the Congress as bought dogs. The banks and financial companies are scaring the hell out of the Members of Congress . The past several years have demonstrated these MC’s do not have much understanding of the financial system.They have even less understanding of accounting. They seem as uninformed as the citizenry.

    We are going to have a lot of teeth gnashing in the rump final session of this Congress after the elections. Those MC’s re-elected in an angry voter year, if it be that, will be most fearful. Those turned out of office will be doing their best to pass legislation desired by their financial system backers. They will have to overcome a Veto if Obama draws any workable political conclusions from the election results if it turns out that the election was a shouted vote of anger.

    This legislation is dead. Besides, the state politicians, for political survival would be required to go to the Supreme Court. States Rights is the wave of the future again.

    This Bill was such a hurried affair it demonstrates a massive fear among financial companies. But , the real problem is not foreclosures but title clouding problems when loans are paid off when a house is sold or simply paid off by contract fulfillment.

    Politicians are bought off with campaign funds to stay in office. It does no good if you get turned out of office no matter how you kiss financial system arse’s. This election will prove or disprove a lot of political beliefs.

    I work a little in local campaigning and it seems to me that nearly all voters are pissed off period. All different ways but nearly all mad as hell.

    Obama must get rid of Geithner to salvage himself politically. But, Geithner and Obama are very similar Yuppies. My bet all along has been that both soothe each other personally. Every governance type needs these kinds of relationships. Substituting myself, my choice outside of political considerations would have been Lloyd Blankfein. Political considerations would have quashed that desire. Obama, understood Geithner within a few minutes of meeting him. Obama chose Geithner in their first meeting. Instant matching chemistry. The Atlantic had a major piece on Obama- Geithner about a year ago. Obama is a hyper rational left brain type. A politician that is very successful is far more in tune with his right brain. FDR was a great example. TR or Grant too.

    November 2-3 will be very interesting days. Still, the notary end run bill was astounding political pimpery and so dangerous from lack of political foresight.

    Comment by Jerry J — October 7, 2010 @ 4:16 PM | Reply

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